Canada’s housing market is something of a national obsession. It’s understandable. It’s also misguided when it comes to Canada’s banks.
It’s all very well for renters to dither about jumping in, or homeowners to fret about what their place will be worth after their kitchen reno. But along with being a tad tedious, all this talk is distracting investors from fundamental improvements in the fortunes of the big banks.
Canada’s big banks report quarterly financial results in August. Analysts are out with previews of the numbers that focus, predictably, on each institutions' exposure to the mortgage market. To sum up all this analysis in one line: No one sees residential real estate as a major concern.
CIBC World Markets Inc. ran something of a doomsday scenario, determining what would happen to profits if the banks suddenly stopped expanding their mortgage portfolios, which are perceived as a critical source of earnings. If growth in mortgage lending dried up completely, which is highly unlikely, CIBC analyst Robert Sedran determined the banks’ future profits would drop by just 1 per cent. “We view slowing mortgage growth as a very manageable headwind," Mr. Sedran said.
“It seems that whether we are late cycle or late-late cycle, the market is more preoccupied with what might go wrong in coming periods than what went right in the last one,” Mr. Sedran said. This backward-looking approach, he said, means investors miss out on the potential of new business initiatives under way at each of the big banks.
While the rest of us were trading stories about a friend of a friend who made millions flipping houses, the big banks rolled out international growth strategies that have nothing to do with Canadian housing. It’s worth noting that each bank is on a very different path.
Royal Bank made a big bet on wealth management in California. Bank of Nova Scotia did three more acquisitions in South America this year, adding to a massive regional platform. Canadian Imperial Bank of Commerce bought a Midwestern U.S. retail network, while Bank of Montreal expanded its U.S. commercial banking franchise.
In the past, results from these forays were overshadowed by strong performance from the banks' domestic businesses. That’s understandable, as even large acquisitions can take several years to make an impact on a bank’s profit. That’s about to change. Mr. Sedran said expansion strategies are starting to make a meaningful contribution to earnings growth, which in turn will boost stock prices.
Which bank has the best growth plan, and is poised to deliver the strongest results? That’s where things get interesting, as analysts can’t agree on who has winning strategy.
It’s likely one or two banks will outperform rivals owing to the success of their foreign investments. That’s a contrast to forces such as interest-rate moves or loan losses – the big waves that tend to wash across the entire sector. Potential gains on foreign investments are significant. Approximately 40 per cent of earnings growth at Bank of Montreal is expected to come from its U.S. expansion efforts, while Royal Bank’s wealth management platform is expected to account for 20 per cent of growth in profit, according to CIBC’s analysis. That means a bank with a successful strategy can break away from the pack.
Favourite picks from CIBC’s Mr. Sedran are Toronto-Dominion Bank, with a strong U.S. retail network that stands to benefit from tax cuts, and Scotiabank, for its South American exposure. Over at RBC Dominion Securities Inc., analyst Darko Mihelic favours Bank of Montreal, based on the potential of its U.S. commercial banking business.
In looking at growth strategies at banks and other public companies, analysts often highlight the potential for “multiple expansion.” It means that, over time, investors will put a higher value, or multiple, on each dollar of profit. In a recent report, Mr. Mihelic said, “BMO has a relatively smaller exposure to a potential slowdown in the Canadian economy and we see good upside as BMO may be the only stock with some multiple expansion potential.”
Canadians are going to keep speculating that a $1-million price tag on a run-down Toronto semi-detached with no parking is a sure sign of a real estate bubble. They may be right. But our obsession with housing shouldn’t distract from the potential for higher profits from the country’s banks.